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Which of the following is/are the components of high-powered money?
  1. Currency held by public
  2. Currency held by commercial banks
  3. Foreign Exchange reserves held by RBI
Select the correct answer using the code given below.
  • a)
    1 and 2 only
  • b)
    2 and 3 only
  • c)
    1 only
  • d)
    1, 2 and 3 
Correct answer is option 'A'. Can you explain this answer?
Most Upvoted Answer
Which of the following is/are the components of high-powered money? Cu...
  • Determination of the money supply is currently expressed in terms of the monetary base or high-powered money.
  • High-powered money is the sum of commercial bank reserves and currency (notes and coins) held by the Public. High-powered money is the base for the expansion of bank deposits and the creation of a money supply. Hence only options 1 and 2 are correct.
  • The supply of money varies directly with changes in the monetary base and inversely with the currency and reserve ratios.
  • The use of high-powered money consists of the demand of commercial banks for the legal limit or required reserves with the central bank and excess reserves, and the demand of the public for currency. Thus, High power money
    • H = C + RR + ER
      Where, C = represent currency, RR = Required reserves, ER = The Excess reserves
  • A commercial bank’s reserves depend upon its deposits. But a bank usually holds reserves in excess of its required reserves. In fact, banks do not advance loans up to the legal limits and remain precisely under that. Hence the need arises for maintaining excess reserves by them.
  • Thus, the money supply is determined by the required reserve ratio and the excess reserve ratio of commercial banks.
  • The formal relation between the money supply and high powered money can be stated as in the form of equations:
    • The money supply(M) consists of deposits of commercial banks (D) and currency (C) held by the public.
    • Thus the supply of money (M) = D + C
  • High-powered money (H) (or monetary base) consists of currency held by the public(C), required reserves (RR) and excess reserves of commercial banks.
  • Thus, High powered money (H) = C + RR + ER
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Community Answer
Which of the following is/are the components of high-powered money? Cu...
Components of high-powered money:

High-powered money refers to the base money or the monetary base, which is the total amount of currency in circulation and reserves held by commercial banks. It consists of the following components:

1. Currency held by the public:
- Currency held by the public refers to the physical currency (coins and banknotes) that is in circulation outside the banking system.
- It includes the currency held by individuals, households, businesses, and non-bank financial institutions.
- This component of high-powered money is issued by the central bank and is not held as reserves by the commercial banks.

2. Currency held by commercial banks:
- Commercial banks also hold a certain amount of currency as part of their reserves.
- Banks keep a portion of their deposits as reserves to meet the withdrawal demands of their customers.
- This component of high-powered money is held by the commercial banks and is not in circulation with the public.

3. Foreign exchange reserves held by RBI:
- Foreign exchange reserves refer to the foreign currency assets (such as US dollars, euros, pounds, etc.) held by the Reserve Bank of India (RBI).
- These reserves are used to maintain stability in the foreign exchange market and to intervene in case of excessive currency volatility.
- Foreign exchange reserves are considered a component of high-powered money as they are assets held by the central bank.

Correct answer:
The correct answer is option A - 1 and 2 only.
- Currency held by the public and currency held by commercial banks are the components of high-powered money.
- Foreign exchange reserves held by RBI are not a component of high-powered money.
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